The recent turmoil in India’s shadow banking sector has brought this issue to the fore and also exposed the absence of a proper framework to deal with such crises.

The problems began a year ago when Infrastructure Leasing & Financial Services defaulted on its payments. The troubles at the Mumbai-based non-banking financial company triggered a liquidity crisis, which spilled over into the rest of the sector.

Companies such as Dewan Housing Finance Limited, real estate lender Altico Capital, and industrialist Anil Ambani-led Reliance Capital are also facing the threat of bankruptcy. “The sector has gone into intensive coronary care unit over the past eight months,” Ambani had said in May.

With many financial services providers in trouble, the Indian government, on November 15, notified rules that seek to extend India’s Insolvency and Bankruptcy Code to “systemically important” FSPs, with assets exceeding Rs 500 crore. Till now, the IBC had provided a resolution mechanism for only corporate defaults. Banks and FSPs were outside its ambit.

Even as experts welcomed the move to provide guidelines for the speedy resolution of stressed FSPs, they are worried about ambiguities. “The new rules are a step in the right direction. Yet, there is a lack of clarity on various issues,” said Akash Gehani, chief operating officer of Instamojo, a Bengaluru-based fintech and financial services provider. In fact, there are many grey areas.

The gaps

What’s “systematically important”?

The government has asked the Reserve Bank of India to define “systematically important” FSPs, that the notification says will be covered under the rules. This has left the industry waiting for more clarity. For now, the rules only state that lenders with assets exceeding Rs 500 crore will be covered.

What is a “default”?

Under India’s IBC rules for corporates, a business can be dragged to India’s debt tribunal – National Company Law Tribunal – in case of default of Rs 1 lakh or more. There is little clarity, though, on whether the same threshold is applicable to FSPs. “If the amount is too small, it could lead to too many businesses being dragged into bankruptcy proceedings even for small defaults,” said Gehani.

Prolonged arbitration

The draft rules say that operations of a defaulting FSP must be suspended once “an appropriate authority” initiates bankruptcy proceedings against it. However, its licence need not be revoked.

Suspension of operation, though, crushes any chance of reviving the company. “Ceasing operations due to bankruptcy proceedings robs an entity of its assets. More customers and staff will leave,” said Rajkumar Bansal, managing director and CEO of the asset reconstruction company Edelweiss ARC.

The rules, also don’t indicate how long the resolution process will last before operations can commence. “If bankruptcy proceedings drag on for long, you lose whatever chance you have of reviving the entity,” added Bansal .

Who is involved in bankruptcy proceedings

The new rules say “an administrator,” or insolvency professional, will be responsible for appointing a committee that will take over the management of a bankrupt FSP. “This may pose potential problems,” said Shristi Banka, founder partner and CEO of Banka CFO, a Mumbai-based financial services provider.

Identifying the person, who would run an FSP, could prove to be arbitrary and time-consuming. “An FSP shall be required to obtain prior permission of the appropriate regulator for initiating liquidation proceedings,” said Banka.

The first company that will come up for insolvency proceedings will be the debt-laden DHFL. The resolution process of the housing lender will prove to be a litmus test for the law.